The current stock market's two-part turn — from "confirmed uptrend," to "uptrend under pressure," and finally to "market in correction" — is a clear message to investors to dust off their sell rules and be ready to use them.
Knowing when to sell stocks requires as much study and experience as when to buy. And some of the harshest early lessons come while watching hard-earned gains — some of them significant — fizzle back to zero or even into a loss.
Best Sell Rules: First Do This
At the top of the sell rule list is the automatic sell rule. This says sell a stock that declines 7% to 8% below a correct buy point after clearing that buy point. The move reduces risk and assures your losses remain minimal, preserving capital for the next breakout.
When markets turn choppy or go into corrections, it is often a good idea to tighten the parameters on this rule up to 3% to 4%. Rotate into cash. Build a watch list. Wait for the market to turn.
When To Sell Stocks: Know The Subtle Signals
IBD and investors.com articles spend a good deal of time discussing moving averages and support. These are not some sort of voodoo boundaries to which stock prices seem to somehow magically adhere.
Institutional investors — the funds, bank and insurance company portfolio managers who drive the market action — use these as guides for adding to or paring down holdings. This is why stocks often "find" or "rebound from" support at their 10-week moving averages.
But a stock dropping below its 10-week line in busy trade is signaling that its big-money backers have let go of the leash. On its own, such a move does not always mean "get out now." But it does hoist an important warning flag to watch out for other potential signs of weakness.
Those can include a breakout that reverses and heads back toward its buy point. In a late-stage base, any breakout that fails — particularly in an uptrend under pressure or market correction — can be considered a sell.
A drop through the 200-day line in heavy trade would be a sell signal. Also, leaders in the same industry group that begin breaking down should place an investor on notice to sell.
Current Stock Market: Selling Into Strength
Getting out of a stock that appears to be breaking down is one thing. But deciding when to sell stocks that have posted sizable gains can be more challenging, both technically and emotionally. After its first-quarter run-up, the current stock market is rife with stocks sitting atop healthy ruins.
The first and easiest upside sell rule is to take profits when a stock rises 20% after a breakout. Stocks tend to base, on average, at 20% intervals. This makes 20% a good place to lock in gains, before a new base begins.
Climax Top Signals
The remainder of rules governing when to sell stocks relate to those that have already had a strong run. These are often discussed in terms of a climax run, as a stock ramps up to the peak of its rally. None of these are hard-and-fast rules, like the No. 1 cut losses rule. But once they start to appear, they often come in twos or threes, sending clear signals that the stock rally's circumstances have changed.
Largest Daily Price Gain In The Rally: A stock should be extended and have climbed for months since its last breakout from a valid base. Watch for its largest single-session run-up of the entire rally.
Exhaustion Gap: A stock gets far extended from its most recent breakout and opens on a gap-up in price from the previous day's close.
Giant Stock Splits: A company announces a massive stock split (think 4-to-1, 7-to-1 or larger) after a significant stock rally.
Breaking The Upper Channel Line: A stock rises sharply above its upper channel line after significant gains. Determine an upper channel line by drawing a line across the three highest peaks over the past four to five months in the stock's rally.
Moon Shot Over The 200-day Moving Average: Prepare to sell if a stock rises more than 70% above its 200-day average.
Keep a list of these rules handy. Learning to act on them will increase your track record of positive sells, decrease your stress level and boost your returns.
Find Alan R. Elliott on Twitter @IBD_Aelliott
